The ongoing evolution in the crypto ecosystem is revealing both opportunities and pitfalls. Crypto assets were originally developed to democratize payments but are mostly used for speculation and, in the case of certain types of dollar-denominated stablecoins, also as a hedge against inflation and currency depreciation. Unbacked crypto assets are the oldest and most popular type of crypto assets, relying not on any backing asset for value but instead on supply and demand. These crypto assets offer limited or no rights for the token holder and are usually issued in a decentralized manner. Users treat unbacked crypto assets as speculative instruments rather than as a medium of exchange.

Nevertheless, innovations that have given rise to the crypto ecosystem, including their underlying technologies, could create potential benefits through greater competition and efficiency in some financial services, such as remittance, trade financing, and cross-border payments. Applying decentralized technologies to real use cases, coupled with appropriate regulation, can offer consumers compelling alternatives to traditional finance.

Crypto asset growth has been volatile, and associated financial stability risks in some emerging markets and developing economies are rising. The total valuation of crypto assets reached almost $3 trillion in November 2021 before falling to less than $1 trillion in July 2022, demonstrating relatively high volatility. Although the size of the market itself is not necessarily a financial stability risk, growing interlinkages with regulated financial services and the lack of regulation might be. The October 2021 Global Financial Stability Report revealed that crypto asset exchanges operating in some emerging markets and developing economies have reached trading volumes comparable to those of local stock exchanges and interbank foreign exchange markets. Despite these large retail holdings, many regulatory authorities do not have conduct or prudential regulation, or payments oversight.

Crypto assets were designed to disintermediate financial services, but new types of centralized entities, such as exchanges and wallet providers, offer key functions to users. These require users to trust centralized entities once again, yet they remain largely unregulated. In some instances, a single entity might offer several key services, such as exchange, storage, and clearing, which could require greater prudential and payment system oversight. The growing importance of these entities could lead them to being considered systemic financial market infrastructures (FMIs).

Global standards applicable to unbacked crypto assets are limited and do not currently mitigate these risks and vulnerabilities. Although standard-setting bodies (SSBs) are making efforts to adjust and develop standards, these remain mostly focused on specific products (global stablecoins), issues (financial integrity), sectors (payments, securities, banking), or entities if they are designated by domestic authorities as systemic. As a result, regulatory gaps in many countries remain material, and crypto’s cross-sector and cross-border nature limits the effectiveness of uncoordinated national approaches. In particular, gaps exist where crypto assets are issued, exchanged, transferred, or stored by nonbank entities and where a jurisdiction’s regulatory framework does not capture crypto assets based on current legal interpretations of financial services and products.

As global standards develop, regulators are encouraged to use all existing tools at their disposal to address rising local risks. The growing systemic implications of crypto assets may warrant immediate regulatory actions, particularly in some emerging markets and developing economies. Regulators should use existing regulatory powers, guided by the applicable international standards, and should focus on areas of vulnerability, such as hosted wallets, centralized exchanges, and financial institutions’ exposures. Actions can range from user education and industry guidance to targeted restrictions.

Authorities should ensure that any short-term approach is flexible enough to be adjusted in the future, in line with market developments and future international standards.

Broad bans on crypto assets are likely to be disproportionate and ineffective in the long run, but targeted restrictions could help address immediate challenges while regulatory capacity is being built.

Authorities should take a balanced approach to harnessing the benefits of technology-driven innovation in financial services, while ensuring that consumers and markets are protected. Over the short-term, and in the absence of global standards, authorities that face severe and immediate risks may need to restrict certain crypto products or activities (such as derivatives, marketing, or use in payments), while still allowing users to buy and sell crypto. However, such measures should not be seen as a permanent solution, as they are disproportionate, likely to stifle innovation, and there are strong incentives and technological alternatives for circumvention. Authorities need to address the underlying drivers for crypto usage, such as weak macroeconomic conditions, misleading marketing, and a lack of trust in traditional financial services.

Any global standards should be comprehensive and risk-based. Domestic regulation should be guided by cross-sectoral global standards, informed by common taxonomies and available data, and provide a level playing field across the activity and risk spectrum applied proportionately to banks and nonbank entities operating in the crypto asset space. Moreover, the regulatory framework will need to be flexible enough to adapt to a changing landscape and risk outlook.

To achieve a consistent and comprehensive global regulatory framework, the following six elements should be considered:   To make global standards effective, common taxonomies are needed. These taxonomies should be developed by SSBs and guided by common groupings of risk, structural features, and economic functions as opposed to marketing and the aspirations of developers.

  Access to reliable and consistent data is needed. It can be challenging to get accurate and consistent data in crypto asset markets, although these are needed to identify market risks and to determine regulatory responses while protecting user privacy. A common taxonomy is one foundational step to improving data collection, but greater regulation, oversight, and cross-border collaboration will be required to close data gaps.

  Global standards should be risk-based, with greater requirements on entities and activities that generate more risk. Licensing and authorization criteria should be clearly articulated, the responsible authorities clearly designated, and coordination mechanisms well defined.

  Global standards should be comprehensive and should cover all important activities and entities.

Crypto asset service providers that deliver core functions and generate key risks should be licensed, registered, or authorized. These include entities related to the storage, transfer, exchange, and custody of reserves, among others, similar to existing rules for financial service providers. Where crypto asset service providers provide multiple functions, authorities should consider the risks generated across the entity and across multiple activities, and additional prudential, conduct, where appropriate, payment oversight requirements should reflect the nature of these additional risks. It is important to cover all the entities because regulating one may not be enough and may leave significant risks in the system.

  If entities or activities become systemic, they should be subject to additional requirements.

Entities that become systemically important should be subject to requirements comparable to those applicable to systemically important institutions, that is, more intensive supervision, safety and soundness, stress testing, recovery, and resolvability. For example, where entities provide critical services with systemic implications, they could benefit from guidance from the CPMIIOSCO principles for systemic FMIs   Regulatory responses should provide a level playing field and address contagion effects.

Consistent yet proportionate rules should apply to existing financial entities as well as nonbank crypto asset issuers (where possible) and crypto asset service providers. Authorities should provide clear requirements on regulated financial institutions (such as banks and insurers) concerning their exposure to, and engagement with, crypto assets. For example, banking, securities, insurance, and pensions regulators should stipulate capital and liquidity requirements and limits on exposures. If regulated entities provide custody services, requirements should be clarified to address the risks arising from that function.

Finally, in addition to the above, Table 1 highlights the potential regulatory responses to key risks. It further underscores that although sector-specific global standards are useful, cross-sectoral coordination is important to achieve an effective regulatory framework for the crypto ecosystem. The Financial Stability Board (FSB) is well placed to take a leading role in coordinating the establishment of global standards to guide the national implementation of regulation of crypto assets while considering sector-specific standards developed by other SSBs. 1 Although this note is focused on unbacked crypto assets, the paper’s regulatory considerations on the broader ecosystem may apply to a wider range of crypto assets, including stablecoins.